The AAF Virtual Debates: Can state-owned banks play an important role in promoting financial stability and access?

The AAF Virtual Debate poll has closed, and the final votes are in. In the final tally, there were 153 "yes" votes and 51 "no" votes in response to the question: "Can state-owned banks play an important role in promoting financial stability and access?" Additional comments on this debate are still welcome.

Thanks to everyone who voted or left a comment—we look forward to hosting more debates in the future. If there are particular questions you would like to see debated on the AAF blog, please suggest them in the comments section.

~~~~~~~~~~~~~~~~~~~~~~~~

Introducing the AAF Virtual Debate

From February 2-14, the All About Finance blog is hosting a virtual debate on state-owned banks. Asli has invited Professors Franklin Allen and Charles Calomiris to weigh in on the issue. Readers can make their voices heard in the comments section of this post and by voting in a poll here. The results of the poll are displayed below.

Comments

One issue with this debate is that the question as asked generates the answer. Even those of us who are painfully aware of the impressive body of evidence showing the damage done by state banks -- the misallocation of capital, discrimination against SMEs, lending to SOEs, high overhead costs, etc -- know as well that this is not always the result. It is possible that SOBs could provide some stabilizing role and some outreach into less populated areas. So of course SOBs CAN play a positive role, it is just that the likelihood of that happening are remote. Even Germany has begun reducing its reliance on state banks, having found that these are too expensive for what they contribute.
The crisis does not change this calculus. Rather, the crisis taught us that when regulations are not enforced and absurd incentives are allowed to take over the sector, the result is a crisis. We have learned that lesson before. Note that Meir Kohn has nicely recounted that the wave of public banks in medieval times was in response to the failures of private banks. The result: virtually all of the public banks failed!

Another issue with the question is that it's too general. My sense of the general answer is similar to Jerry's for reaons having to do with incentives, conflicting objectives, political, and conflict of interest reasons, many of which are inherent to SBs. But I would quibble w the view that this crisis did not reveal (at least in the "perfect storm conditions" of the Great Recession) equally problematic incentives and disastrous results in what was supposed to be a well regulated, transparent, and rules-based private banking system.
So it seems to me that we neeed answers to more specific questions: what, really, are the examples of successful SOBs, since failures seem all too well documented? And is this success unambigious and firmly established upon digging deeper? Under what conditions did this 'success' take place? And are these conditions common, crisis-related, or entirely circumstantial? These basic answers, in addition to those from comparative analyses of performance of state vs private banks, could shed light on both specific and general questions in this debate.

Jerry,
I went back and forth with that wording. Past evidence is clear I think; so if you rule out exceptions, it is difficult to argue at least from an academic standpoint, state banks have contributed significantly. But the question is also meant to be more forward looking; we really don't know quite how well they have done in their countercyclical role in the last crisis. Where has the money gone? How well have they done in allocating the credit in the midst of the crisis? Remains to be seen..
Asli

I see little evidence that public sector banks are better at preventing or solving a crisis, or efficiently further development objectives. From Fanny and Freddy to Banco de Cafes and government owned savings banks in Europe the evidence is not encouraging. There seems to be an almost irresistable tendency to pursue unsustainable ideological goals, become a tool for political objectives, function as a retirement for political allies or distort the markets. In addition, no matter how narrow their mandate is defined, over time the government banks tend to expand their activities, begin to compete with private sector banks and enter sectors for which they are not appropriately qualified. Ultimatley, I am afraid the government banks do more harm than good - even with the best of intentions.

The academic literature has extensively discussed about this issue in terms of profitability and efficiency of the SOBs. While from the macro-economic point of view, the question is that does credits from SOBs work good as a countercyclical policy instrument and promote a sustainable and stable long term growth? People may put their votes in favor of SOBs based on the experience of China, the country on top of the ranking of both share of SOBs and economic growth during the crisis. But China is facing serious inflation risk now due to the unconstrained credit issuances by the SOBs as policy instrument during the crisis. It would be interesting to check the correlation of the business cycles of developing countries with the credit issued by the SOBs. I won't be surprised of seeing large overshooting effects to the cycles by SOB credits, which may produce if not larger fluctuations in the long run. I would agree with Mr. Schmitz, that SOBs may not be a reliable solution for crisis management. An appropriate regulation framework and financial institutes running under market force would be more fundamental. Of course, what is an appropriate or optimal regulation framework is another hard question for development finance economists.

State Banks are great for throwing conferences and keeping otherwise unemployable academics from littering the pavement as members of the homeless class.
State owned institutions typically have an understood state mandate of protection and therefore cheaper borrowing. Fannie Mae and Freddie Mac are examples of this. Lending is often a commodity business and the cheapest money wins.
Gresham's law, whereby bad money crowds out good money in banking markets usually means the state enterprise with cheap capital ends up dominating the sectors they are involved in. In the US Fannie Mae and Freddie mac ended up with +70% of the US mortgage market.
The role of a bank is allocating capital. The role of the state is insuring the rights of its citizens by upholding the law. These roles do not explicitly or implicitly overlap.

Thee posted question I agree, is very general; are we talking about SOBs in advanced and mature economies and financial systems for instance in the US or are we talking about SOBs in emerging markets or developing economies? The answer will likely differ, because the SOBs may be the only capable institutions to undertake macro policy functions. May be the role of SOBs has an inverted proportional role to the maturity of the financial markets.

It is not that the question is very general, it is that it lacks structure to obtain a sensible answer.
Everything should be cost-benefit related. And on a relative basis, even in emerging markets and developing economies, a privately owned organization will perform better than a public owned enterprise in terms of delivering goods or services at lowest cost, as long as any government incentive (subsidy or community service obligation payment to the service provider) is properly structured and monitored.
As long as the government does not act in a way that prohibits or resptricts the development of the private sector, it will do a far more efficient job than a public sector counterpart!

In India almost all villages are covered by one SOB or other.Priority sector lending is getting channalized through these Bank Branches.SOBs play a very vital role in Agrecultural Lending in India.Most of the private Sector banks operates in Urban and metro areas in India.We can practiclly conclude that the SOBs are the main source of Finance for small farmers and other artizans working in diffrent occupations in India.Diverting Agrecultural credit for commercial Lending has resulted in the suicide of 17683 farmers.This was due to non availability of credit and exorbitant rate of interst charged by Money lenders in India last year.
The Private Sector banks are not interested in Mass banking in India and concentrate only on effluant sections of the populations in the Urban areas.
Prior to the financial crisis there was discussions about merging SOBs to create few Big SOBs who can finance huge Infrastructure projects in India.But after the Financial crisis now goverment is in favour of many no of small banks.This can mitigate the risks of Big Scams involving few Big Banks.

Its very important that SOBs should be participating in the growth of the country and especially during the time of crisis. The instructions should be coming from the Central Banks and the Finance department of the country.
The situation in India is quite a different, in Andhra Pradesh and some other states where MFCs have financed the small farmers and other SMEs have done a good and a bad job. They invested and given loans a lot but without a proper direction and understanding the future situation. Ultimately many farmers committed suicide, thereafter government and central bank took steps to change the situation and control it.
Looking on the other hand in PIIGS nations and especially Greece where the situation was very worse, its only the policies adopted by central bank has worked in handling the situation.

"YES"
Financial stability as the word suggests depends on the sustainable financial growth.
With reference to SOBs, the promotion of financial stability depends upon the factors such as how professionally the financial regulations are earmarked and adhered to by SOBs.
A clear defined mission statement having finacial viability in its working for any SOB is key to the promotion of financial stability.
A very clear regular check and balance mechanism is a must for loans not falling prey to NPA (Non Prforming Assets)for SOBs.
Social Objective of the SOBs can be best achieved to the highest level of satisfaction in a sustained manner when and only when loaning and funding campaign have parameters to serve as a watch-dog for the SOBs financial health.
The reasons of the failure of the private sector banks revolves around above benchmarked feasability criteria.
The social welfare quotient should be matched with the Cost-benefit analysis quotient and the Opportunity Cost quotient for all time success of SOBs in promoting the financial stablity and access.
SOBs do have an exceptionally upper end in demonstrating the same by virtue of its clear State Mandate and long term commitment for promoting financial stability across the border.

May I have a clarification about our definition of SOBs? Are we discussing the state owned commercial banks, which take deposit from the household and private sector and provide credit, or the policy banks, which are financed through bond issuance or government fund? My understanding is the functions of the two should be clearly different.

This blog just came to my attention now as I was just expressing my doubts about the close ties between one majority state-owned bank in Turkey, Vakif Bank, and a private construction company, Limak. At a Public Private Partnership (PPP) Conference last week in Zagreb, Croatia, the PPP Agency of Kosova presented the competitive tendering process for a PPP to its national airport. Apparently Limak, the Turkish construction company, had managed to raise the financing, close of US$ 1 billion, from the majority state-owned Vakif Bank. This no doubt must have changed the playing field for all other competitors for Kosova's national airport. Moreover, the Turkish Treasury must have agreed to bear the liabilities for this very loan.... Those of us working on PPPs in infrastructure projects should not ignore the role of the state-owned banks behind the so-called private sector (selectively available to few only) and how the liabilities one day might hurt the taxpayers (if not properly calculated and entered into the budget). More research is needed to explore the implications of the close ties between PPPs and state-owned banks and if we can even properly call them public private partnerships where even the source of the funding is public from one country to another county's state-owned airport.

State owned Banks can only serve the state if there are proper policies and guidelines that are adhered to.
Once corruption sets in though, the national banks can tend to fuel the corrupt plans of corrupt leaders, thus defeating the purpose of their existence which is to fuel economic development in the nation.
e.g. Policies enabling borrowing by the vast majority at low interest rates will definitely fuel economic development as opposed to funding projects set up by corrupt leaders that become white elephants while the money goes to a few select pockets....

After the latest financial crises most economists are still finding it dificult to add a clause or state factor to the widely accepted financial theories of privatisation or liberalization. Whoever that is still finding it ambiguous to accept the prominent role of a 'good run' SOB's in promoting finantial development is doing sofor two reasons, (1)Neivity (2) proudness.
The questions we should ask are if the SOB's could be run free from political biases, if it could enerstly support SME's, if they could offer loans to development projects without charging unjustified interest rates, how can the board be made more accountable without having the state protecting a few interes. All these and more require more research........

There is a bit of disconnect between the results of the survey (3:1 in favor of state-owned banks) and the debate, in which “skeptics” are seemingly at least as vocal as those in favor of state-owned banks. Does it have something to do with the formulation of the question (as suggested by Jerry Caprio)? Or are the skeptics more vocal?